United States: SEC Issues Final Rule To Expand Test-The-Waters Communications To All Issuers

Last Updated: October 9 2019
Article by Shearman & Sterling LLP

On September 25, 2019, the Securities and Exchange Commission adopted a new rule that will enable all issuers to "test the waters" prior to publicly filing a registration statement. Currently, only emerging growth companies, or EGCs, have this ability. The new rule will permit non-EGCs conducting IPOs to have discussions with potential investors. It will also enable non-EGCs that are already public to have confidential discussions with potential investors in connection with contemplated follow-on offerings where these non-EGCs do not have a public registration statement on file that covers the relevant securities. The new rule will become effective 60 days after the rule's publication in the Federal Register.

New Rule 163B under the Securities Act will permit all companies (and their authorized representatives, including underwriters) to engage in communications with investors that are, or are reasonably believed to be, QIBs (qualified institutional buyers as defined in Rule 144A under the Securities Act) or IAIs (institutions that are accredited investors as defined in Regulation D under the Securities Act) prior to or after the filing of a registration statement to assess investor interest in a potential registered offering. Under the new rule, these communications are exempt from the prohibition imposed by Section 5 of the Securities Act on making written or oral offers prior to the public filing of a registration statement with the SEC. These communications are also exempt from Section 5's prohibition against using written offering materials other than the prospectus.

Companies that do not qualify as EGCs, which generally means that they have annual revenues in excess of US$1.07 billion, are currently unable to "test the waters." In addition, companies that were EGCs at the time of their IPO lose that status once they have been public for a year and have a market cap of at least $700 million or once they have been public for five years.

Companies that qualify as well-known seasoned issuers, or WKSIs (generally, companies that have been public for at least a year and have a market cap of at least $700 million), already have the ability under existing Rule 163 to, among other things, make oral offers to investors prior to the public filing of a registration statement. That rule, however, does not cover communications by underwriters, which has limited its usefulness in practice.

We believe the types of transactions that will benefit most from the increased flexibility provided by the new rule will be the following:

  • IPOs by companies that do not qualify as EGCs. The new rule will make it possible for non-EGCs to engage in test-the-waters communications prior to the initial public filing of the registration statement. (Oral communications are already permitted after that first public filing.)
  • Follow-on equity offerings and registered debt offerings by non-EGCs that do not have a public registration statement on file. The new rule will enable issuers to test investor appetite for a new registered offering through confidential discussions prior to publicly filing a registration statement. Filing a registration statement may raise signaling concerns when it occurs out of the shelf renewal cycle or is inconsistent with the issuer's historical practice.

In both cases, the new rule will work well with the SEC staff's existing accommodation permitting confidential submissions of draft registration statements in connection with the initial registration of IPOs or spin-offs and in connection with follow-on offerings within one year of the effectiveness of that initial registration.

In view of the fact that communications under the new rule are limited to those potential investors that are, or that issuers and broker-dealers reasonably believe are, QIBs or IAIs, the rule does not require issuers to file or include specific legends on test-the-waters communications made under Rule 163B. We expect, however, that market participants will continue to use legends that have become customary for test-the-waters communications by EGCs. We also expect that, just as in the case of EGCs, test-the-waters materials under the new rule will generally not be left behind at investor meetings and therefore not be considered "written communications."

Test-the-waters communications under the new rule will expressly be considered "offers" under the Securities Act and, consequently, will be subject to potential liability under the Securities Act and other federal anti-fraud provisions. More importantly, a company subject to Regulation FD, which includes all public companies, needs to determine whether test-the-waters communications would be considered disclosure of material non-public information and whether it has an obligation to simultaneously make such information public or whether it can avail itself of an existing exception under Regulation FD. For example, under Regulation FD, if the investors in test-the-waters meetings enter into confidentiality agreements, a company may, in certain circumstances, conclude that public disclosure is not required at that time.

The new rule is non-exclusive. Companies will therefore be able to rely on other Securities Act communications rules or exemptions when assessing the means and timing of communication with potential investors prior to a contemplated offering.

View the final release adopting the new rule. The text of the new rule appears at the very end of the release and is copied below.


§ 230.163B Exemption from section 5(b)(1) and section 5(c) of the Act for certain communications to qualified institutional buyers or institutional accredited investors

(a) Attempted compliance with this rule does not act as an exclusive election, and the issuer also may claim the availability of any other applicable exemption or exclusion. Reliance on this rule does not affect the availability of any other exemption or exclusion from the requirements of section 5 of the Act (15 U.S.C. 77e).

(b)(1) An issuer, or any person authorized to act on behalf of an issuer, may engage in oral or written communications with potential investors described in paragraph (c) of this section to determine whether such investors might have an interest in a contemplated registered securities offering, either prior to or following the date of filing of a registration statement with respect to such securities with the Commission. Communications under this rule will be exempt from section 5(b)(1) (15 U.S.C. 77e(b)(1)) and section 5(c) of the Act (15 U.S.C. 77e(c)).

(2) Any oral or written communication by an issuer, or any person authorized to act on behalf of an issuer, made in reliance on this rule will be deemed an "offer" as defined in section 2(a)(3) of the Act (15 U.S.C.77b(a)(3)).

(3) Any oral or written communication by an issuer, or any person authorized to act on behalf of an issuer, made in reliance on this rule is not required to be filed with the Commission, including pursuant to § 230.424(a) or § 230.497(a) of Regulation C under the Act or section 24(b) of the Investment Company Act of 1940 (15 U.S.C. 80a-24(b)) and the rules and regulations thereunder.

(c) Communications under this rule may be made with potential investors that are, or that an issuer or person authorized to act on its behalf reasonably believes are: (1) Qualified institutional buyers, as defined in § 230.144A; or (2) Institutions that are accredited investors, as defined in §§ 230.501(a)(1), (a)(2), (a)(3), (a)(7), or (a)(8).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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